Justify the circumstances that are best suited for the dividend growth model approach versus the price-to-sales ratio model to value a firm. provide an example of each. create an argument for using the free cash flow valuation approach for equity valuation. provide support for your argument.

Explanation:

(A) THE DIVIDEND GROWTH MODEL

The circumstances that are best suited for the use of this model to value a firm and the justification for using this model in such circumstances are:

1. If you want to value a single firm. Why use this model in this case?

This model gives absolute valuation of a SINGLE FIRM'S dividends.

2. If the company to be valued pays dividends. Justification:

There are various ways to value a firm. For each of the methods, certain characteristics of the firm are considered or computed. If the firm you wish to value pays dividends (has shareholders) and the dividends are stable and predictable, the Dividend Growth Model should be employed.

3. An example of such a firm is the Coca-Cola company. Another example is Disney Corporation. These are financially mature multinational firms operating in well developed industries hence they have shareholders and pay dividends (stable dividends).

(B) THE PRICE-TO-SALE RATIO MODEL

The circumstances that are best suited for the use of this model to value a firm and the justification are:

1. If you want to value a firm, relative to other similar firms. Why? This model gives RELATIVE valuation of a firm's stock.

2. If the firm in question does not pay dividends or the investor wants another measure of company stock value asides dividends.

3. If the investor does not want a model as mathematically cumbersome as the Dividend Growth Model

4. If the firm is publicly traded; if both the stock price and the sales of the firm are available.

5. If the firm has positive sales which are not too volatile.

(C) FREE CASH FLOW VALUATION APPROACH

Arguments/Reasons for using this approach to equity valuation:

1. If a company does not pay dividends or has irregular dividend pattern.

2. If a firm has stable, positive and predictable free cash flows

3. Firms that have the ideal cash flows suited for this model are usually mature firms that are past business growth stages.

Goodluck.

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